Who gets the family cottage … and how?

Holding onto memories while letting go of ownership

Some of the hardest estate planning decisions are not about dollar values, but about personal values. A prime example is the family cottage, where the memories are many, and the mere mention of letting-go can be painful.

Unfortunately, it’s not much easier on parents who intend to keep it in family hands rather than sell to strangers. Among those you love, it can be even more emotionally troubling to decide when, how and to whom ownership will pass.

To prepare for these tough choices, it’s helpful to have a clear understanding of tax and legal rules so that you can anticipate hurdles and consider options.

Tax liability for parent as seller/transferor

Apart from spousal transfers, a change in beneficial ownership is a taxable disposition. Half the increase in value from the adjusted cost base (ACB) to the fair market value (FMV) is added to the seller/ transferor’s income for that year. The ACB is generally the acquisition price plus capital improvements.

The tax bill could be reduced by claiming the principal residence exemption (PRE), though that would limit use of the PRE on a future disposition of other concurrently owned residential properties.

Options for passing ownership to one or more adult children

In an arm’s-length sale, a seller transfers ownership without control or concern as to how that arm’s length purchaser holds title. In family situations, there are more options that parents may consider:

Direct transfer to one child

Even if little or nothing is paid in return, a full disposition is deemed to occur at FMV for purposes of calculating the capital gain. Thereafter, the child has all rights of ownership.

Adding joint owners

A proportionate disposition is deemed for each added owner. For example, a widowed mother who adds 2 sons is deemed to dispose of 2/3 of the value. The later death of any joint owner is a disposition of that person’s share, with the survivors continuing to own the property together.

Using tenancy-in-common

A parent could direct a specified percentage to transfer to one or more children, to be held as a tenant-in-common. Like joint tenancy, there is a disposition on initial transfer and on an owner’s death, but the deceased’s rights pass to his/her estate, not to the surviving owners.

Tax-deferred trust transfer

Parents over age 65 could transfer the cottage into an alter ego or joint partner trust for their current benefit, with the children as contingent beneficiaries. The property is not deemed disposed until both spouses die, at which time capital gains would be calculated and tax due.

Transfer to a lifetime trust

The parents may be content to trigger a taxable disposition to a trust now. They could maintain legal control as trustees, with future gains accruing to the children as beneficiaries.

Estate distribution possibilities

If the cottage is held to the second spouse’s death, the capital gain arises at that time. The cottage could then be transferred to the children (tenants-in-common or joint owners, as desired) or continue to be held in trust according terms as outlined in the last deceased’s Will.

Funding the tax liability

Allowing that the PRE may be claimed in some situations, tax on the capital gain is usually inevitable. And if it’s large, the decision may be to delay triggering it until death. Parents could buy joint last-to-die life insurance to pay the tax, or allow that other estate assets will have to be sold to raise the needed cash.

Hidden costs of cottage ownership

All decked-out at your cottage, cabin or chalet

You look out across the rippling water admiring the rise of evergreens painted against an indigo sunset. A warm breeze on your face, a deep relaxing breath, a cold beverage at hand … priceless, right? Wrong.

Whether you’re reminiscing from younger days, recalling a recent visit with a friend or just holding an image in your mind, cottage life can be very appealing. Savour these memories fondly, and dream what feelings the future holds.

At the same time, you need to be thinking both conceptually and practically about the cost of that life of leisure. Without puncturing those visions entirely, let’s look at some of the costs and trade-offs of owning vacation property.

There and back again: The cottage commute

Be sure you are up to the travel back and forth. Weekend cottage migration can be time-consuming and costly, as gas is obviously not free.

If you are able to work remotely, maybe you can ease your woes by heading up a weekday earlier or staying on while others join the Sunday stream of headlights. That can be a sanity-saver but can also impose its own costs, especially if you need rural high speed internet access.

And if you’re breaking the family into two vehicles to coordinate commuting, that convenience will cost you.

Year-round or seasonal? Measuring your maintenance

Is this your getaway or a duplicate home? Either way, you need furniture (rustic though you could choose it to be), appliances and the periodic roof, fence or deck mending.

For bills and utilities, some will vary by usage or may be available seasonally, while others like property tax will apply annually. For year-round access, you may need a local snowplow contractor, or at least own a dependable snow blower.

Careful not to be trapped by the trappings

Just being at a cottage is good for some, but ‘doing’ is what many people look forward to.

Often that means being out on the water, or at least at its edge. That can range from a foam floaty, to a canoe or kayak, all the way up to a powerboat with water-ski line.

Again, there’s the cost of gas? Though smaller items can easily be packed away, motor craft will have to be winterized and may require offsite storage.

Keeping it clean and tidy, and sharing your good fortune

Do you like housework?

Hopefully so, because you now have two houses to take care of. Don’t mean to rain on the parade, but we all had chores at our family cottage, and they doubled-up when we had guests coming.

Of course, welcoming visitors is a large part of the charm (and it’s a good antidote to cabin fever with one’s family), but guard yourself against going from gracious host to inundated innkeeper.

Renting to ease the finances

If you’re stretched to carry the place, whether from the outset or once you’re established, you could consider renting it out to defray some cost.

This is a lifestyle concession as much as a financial boost, as you may have to concede prime times when you would like to be there yourself. But with prices being at historic highs, this may be the route for you if you are intent on making cottage realty your reality

Is it time to revise your Will?

Three prompts to keep your estate planning current

For some people, even the thought of creating a Will casts a pall over their mood. Yes, a Will deals with a person’s death, but the broader process of estate planning is about caring for the most important people in your life. Having an up-to-date Will is central to that process.

But how do you know if you are really “up-to-date”? Realistically, it isn’t feasible for you to constantly adjust your Will, but the three prompts discussed in this article will help you keep on top of any necessary changes.

The purpose of a Will

Estate planning is about taking care of yourself now and in the future. It is also about taking care of the people around you – now, in the future and when you are no longer there.

As much as the phrase “taking care” expresses your values and emotional commitment, it has an equally important practical purpose. With a clear picture of who is the focus of your planning, you’re in position to manage your property to fulfill your intentions during your lifetime, and to prepare for the eventuality of your death – that being when your Will takes effect.

With the benefit of good legal guidance, your Will will be drafted within the boundaries of the law, while anticipating reasonable contingencies. Still, there is nothing more constant than change itself, and that also applies to the people, the property and the law of estate planning.

When to review your Will – The 3 P’s

What then may prompt the review of a Will and thus require a discussion with your lawyer? The potential changes to your circumstances can be grouped into the following three categories, which are listed in order of priority:

1. People changes

This includes you, a dependent, a Will beneficiary, an immediate family member (whether or not a beneficiary), an executor, or a trustee or guardian.

- Beginning or end of a close personal relationship, whether or not legally married
- A birth, adoption, death, mental capacity concern or significant health event
- Immigration, emigration or change in citizenship, and even a permanent move to or from the province
- A change in liability exposure, such as a bankruptcy, being joined in a lawsuit, signing a guarantee or starting a business

2. Property changes

Your Will is used to direct who will receive the property out of your estate, which in turn is the property you own when you die. Changes in the nature, legal title and dollar value of property could affect proportions among beneficiaries, and at the extreme could effectively disinherit one or more of them, intended or not.

- Sale of a large asset, especially if it is the subject of a specific Will bequest
- A windfall, such as an inheritance, court award or lottery prize
- A theft, loss or consumption, including a marked decline in or withdrawal from an investment account, especially for an RRSP/RRIF plan where a beneficiary designation is in place that was designed to coordinate with inclusion or exclusion of beneficiaries in a Will
- Ownership change or transfer, including loans or gifts to Will beneficiaries, a change to bank signing authority, or the addition of a joint owner on investments or real estate
- New life insurance, or cancellation or loss of insurance (for example, on retirement from employment) where the plan proceeds or a beneficiary designation were factored into Will planning

3. Passage of time

Even if you and the property have remained effectively the same, the legal landscape may have shifted beneath you. The principal sources of law are the courts, provincial legislatures and the federal Parliament.

- Case law – A judge may have ruled in a court case where the strategies, circumstances and or facts are similar to your situation and planning decisions.
- Provincial law – Changes may be made to legal entitlements or processes. For example, in 2020 Manitoba eliminated its probate fees, and as of 2021 Ontario no longer treats a marriage as revoking a pre-existing Will.
- Federal law – Changes are regularly made in tax legislation, so there could be developments that could have an impact on Wills, or the administration of estates and trusts.

It is difficult to say exactly how often you should review your Will, but it is commonly suggested that you review it at least every five years. Though the timing of court judgments is somewhat random, political change is more predictable. A sitting provincial or federal government must call an election within five years, and there could possibly be two elections in that time.

Testamentary trust tax changes

Indeed, one of the most significant estate tax changes came about just over five years ago. For decades, testamentary trusts – those created through a Will – were entitled to preferred tax treatment. As of 2016 they are now taxed at the top tax bracket, near or exceeding 50% in most provinces, with two key exceptions:

- Graduated rate estate – For the first 36 months of an estate, graduated tax brackets apply. However, the rules are complex, and if not carefully navigated, the preferential treatment may be lost.
- Qualified disability trust – Ongoing graduated-tax-bracket treatment may be available to a testamentary trust with a beneficiary who is qualified for the disability tax credit.

Wills drafted and executed before this development may have included one or more testamentary trusts to take advantage of the tax rules in place at the time. Today, those trusts will have little or no tax benefit and may turn out to be an impediment to efficient estate administration. For those who have benefited from what was good planning in the past, it may be time to call the lawyer and discuss appropriate planning in this new environment.